Top Tabs

Monday, March 21, 2011

Ecology and Environment: Minority Report

Ecology and Environment (EEI) provides consulting services to customers looking for green-friendly solutions. Revenue has been ramping up as of late, as the world becomes more eco-friendly and searches for "sustainable"-type solutions: revenues in 2010 were about 40% higher than revenues in 2007. But while the company's operating income over the last 12 months is over $13 million, this growing company trades for $80 million despite a net cash balance of $15 million.

To some extent, the downside is protected here. Because of the nature of this business, whereby the company bills its consultants out at a higher rate than what it pays them, it would take severe mismanagement for the company to lose money. Consultants with advanced degrees do not have the kind of job security enjoyed by government unions, for example; if demand for EEI's services tanks, the company should be able to easily cut its staff to a level commensurate with revenues. This concept was applied similarly about four months ago to a company by the name of TSR, where downside risk was deemed limited; the results were excellent.

But in this case, there is no discount to book value, and therefore the downside is not protected completely. For shareholders to be fully protected, the company will have to keep earning a decent amount, and that's far from guaranteed. The company derives about 1/3 of its revenue from US governments, including two federal contracts that will expire in the coming years. If these are not renewed or replaced by other projects, revenues and earnings are likely to suffer.

In addition, when valuing this company, it's important to consider more than just its operating income. This is because the company has consolidated entities which it does not fully own, meaning some of the profits are siphoned away to minority interests. Last quarter, these interests grabbed about one quarter of the company's after-tax income. Factoring in these interests can result in a much less appealing estimate of intrinsic value!